Any fears that the net lease market would crash under the weight of the COVID-19 pandemic disappeared quickly as the sector continued to draw the dollars of investors even during the most challenging days of 2020.
And today? Net lease assets remain one of the most attractive options for investors. And those working in this field say they see few signs that this will change.
BJ Feller, managing director and partner with the Chicago office of Stan Johnson Company, said he saw just a brief pause in net lease activity during the earliest months of the pandemic.
But after June of last year? Investors again returned to net lease assets, he said.
“There was a moment of uncertainty when investors didn’t know how everything would play out,” Feller said. “But then in the summer of 2020, net lease assets saw this incredible rebound of activity. It has since been incredibly robust for all of the net lease commercial assets.”
Why did activity rebound so quickly in the net lease market? Feller points to several factors. First, there was a dramatic pullback in Treasury rates. Rates that were once north of 2 percent suddenly dipped to less than 1 percent.
At the same time, lenders remained active even during the height of the COVID-19 pandemic. This represented a significant difference from the Great Recession in 2008. Back then, lenders pulled back. During COVID, though, lenders were still willing to loan money to investors and developers.
Then there’s the nature of net lease assets itself. Unlike other forms of real estate, net lease properties mostly run themselves. That makes them more attractive to investors who aren’t interested in hiring property managers or managing a property themselves.
“Net lease gives you the chance to get into real estate, with its returns and tax benefits, without having to be this active manager,” Feller said. “That’s what people like about net lease. As the Baby Boomers age, they are realizing that net lease real estate is a good investment for the later third of their lives.”
Mark West, senior managing director for net lease in the Dallas office of JLL, focuses on net lease assets across the country. He said that this market has been active throughout the last 19-plus months.
Why? West said that net lease assets are easier ones for investors to take on.
“They are very passive investments,” West said. “They don’t require a lot of landlord responsibility, if any at all. They pay reoccurring dividends, which is very nice. In uncertain times, these are very attractive assets. They are passive, long-term investments, much like a bond, but you have a hard asset with very durable income.”
Randy Blankstein, president of The Boulder Group in Wilmette, Illinois, agreed that the net lease sector is on a hot streak now. Part of the reason? The market at the end of the third quarter was seeing historically low cap rates.
“Activity has been picking up as the year has gone on,” Blankstein said. “This is a market that is searching for yield. Investors are looking for safe, high-yield assets. Net lease is very much in vogue this year. This market has done extremely well. Volume has been really strong.”
Different sectors, different results
As Blankstein says, net lease assets during the pandemic did exactly what they were supposed to do: They yielded a steady return for investors.
“Volume was down tremendously in the second quarter of last year,” Blankstein said. “But since then, month by month, quarter by quarter, the volume has picked up since that date. We are now in a very robust market.”
But in little surprise, investors are focusing on the best-performing net lease assets, Blankstein said.
Not all net lease assets are performing equally today. Industrial and multifamily remain the favored classes for investors.
It’s little surprise that industrial is performing so well. Even before the pandemic hit, customers were spending more of their shopping time online. And when they ordered products from Amazon or other online retailers, they wanted them to show up at their doors in fewer days.
That led to pressure on companies to open a greater number of warehouses across the country, something that has led to demand soaring in the industrial market. The pandemic has only boosted the public’s appetite for online shopping.
“The pandemic took trends that were probably going to take three to five years to play out and accelerated them,” Feller said. “We saw probably 60 months of change and progress happening in 12 months. People were already bullish on industrial. The pandemic transformed industrial from Miss America to Miss Universe.”
Stephen Wolff, vice president for industrial at Dallas-based Spirit Realty, said that all types of industrial have been strong performers since the start of, and before, the pandemic.
“There is a lot of demand across the board,” Wolff said. “It’s not just Amazon distribution facilities. Light manufacturing is in demand. Heavy manufacturing is seeing more demand than it has in years. Cold storage is a very active sector. Across all food groups, industrial is doing well.”
Wolff doesn’t see this demand lessening anytime soon. The pandemic has changed the way people shop, travel and socialize. These changes aren’t disappearing, he said.
“This is the world we live in now,” Wolff said. “This is the new norm. There is no end date when we go back to normal. Real estate is included in that.”
This always rising demand for industrial product has posed challenges for companies like Spirit Realty. Wolff said that with demand so high and cap rates so compressed, it can be difficult for investors to acquire properties with all the competition in the market.
How is Spirit Realty dealing with this? Wolff said it takes a lot of work.
“We are fighting it out with everyone else,” he said. “If a broker has an opportunity to show something off-market, if brokers have the opportunity to show a property to six or seven of their best relationships, we get those calls. I have great relationships in the market. The certainty of close with Spirit Realty is very high.”
Wolff said that consumers have gotten comfortable with buying everything online, from food and medication to clothes and school supplies.
“You might have distributors of consumer products that are working in a 100,000-square-foot warehouse. The demand for their product might have soared 20 percent or 30 percent during the pandemic,” Wolff said. “Suddenly, they need more space for distribution. They are now out in the market looking. Everyone is still buying things, but they’re doing it differently.”
Steady in multifamily
The multifamily asset class has remained attractive to investors, too. When the pandemic started, the fear was that renters would stop paying their monthly rents. For the most part, that hasn’t happened.
People have to live somewhere. This meant that for many, paying their apartment rent remained a priority, even during the pandemic.
“Anywhere where people could do their jobs from home, we saw very little in missed rent payments,” Feller said. “That was the great line of demarcation when it came to the economic impact of the pandemic, people who could work from home and those who couldn’t. The disruption was not as severe as anyone thought it would be for multifamily.”
Blankstein said that investors are focusing on better products today. That means industrial, of course. But it also means retailers that were deemed essential throughout the pandemic, such as Walgreens, Target and Walmart.
Quick-service restaurants with drive-throughs, too, have performed well throughout the last 19-plus months, and these assets continue to attract investors.
“People are focused on tenants that are expanding,” Blankstein said. “Everyone understands how well McDonald’s and Chick-fil-A have done during the pandemic. The quick-service restaurant with a drive-through looks to be the future. If you want a quick-service restaurant today you need a drive-through or a double drive-through.”
This trend might increase movement in the net lease space. Blankstein said that quick-service tenants locked into strip centers are eager to move to new locations that allow them to add drive-through service. Blankstein pointed to restaurants such as Panera and Dunkin’ that are now looking to increase their free-standing locations. Spots inside strip centers are no longer as attractive to these restaurants.
“People adjusted during the pandemic,” Blankstein said. “They want drive-through service. Many of the changes in consumer behavior during the pandemic are going to stick around.”
Dollar stores, too, are an attractive option for investors, Blankstein said. These retailers, mostly serving more rural communities, have thrived during the pandemic largely because they give consumers the chance to get in and out quickly. As Blankstein said, when you need a few items on the way home from work, you’d rather run into a Family Dollar than a busy Walmart.
Dollar stores are also a bargain for new investors. They’re a way for investors to get into the net lease market without spending the type of money it’d take to purchase a multifamily building or industrial property.
Facing the challenges
Other net lease sectors, though, are facing challenges. Plenty of uncertainty plagues the office market, for instance, as it’s unknown when companies will start bringing their employees back to the office.
And when employees do return, who knows how many will work full-time in the office? Many companies are contemplating hybrid work schedules in which their employees spend time every week working remotely.
“People are realizing that this is a five-year story, potentially even longer,” Feller said.
Feller said that public transit might be the biggest differentiator when it comes to office markets. Those office markets in which most people commute to work via public transportation might take longer to recover than those in which more people drive to work, he said.
West, though, said that he is seeing a slow but steady rebound in the office market today.
“The farther we get away from the start of the pandemic and the closer we get to our normal work environment, the closer to normal you see the office market becoming,” West said. “You are starting to see office building occupancies creeping up. In the net lease space, you have long-term net leases. So these assets are going to be desirable because there is no leasing risk.”
Of course, not every city is seeing workers returning to offices at the same rate. West said that cities such as New York City and San Francisco are not reopening quite as fast as others. Offices in these cities, then, might not return to normalcy as soon.
“But it’s undeniable that the whole business world is not going to work from home forever,” West said.
Then there is retail. Feller said that much of the physical retail market already went through the pain associated with ecommerce long before the COVID-19 pandemic hit. Retailers already knew that they had to operate both in the physical and online spaces, taking an omnichannel approach, to be successful.
“People think of retail as being either online or brick-and-mortar,” Feller said. “But retailers know they have to operate in both environments.”
A bright future?
Why has the net lease sector been so resilient during COVID? Blankstein said that net lease assets typically feature stronger, more successful tenants. These tenants are built to perform better even during challenging times.
“You have tenants like the Apple Store and Lululemon. These are high-volume destination retailers,” Blankstein said. “For the most part, it’s not the nail salons and dry cleaners. Net lease has better tenants to begin with. Those better tenants have outperformed the smaller ones during COVID in general.”
And what does the future hold for industrial? This sector is due for a slowdown, right?
Wolff isn’t so sure when that might happen. The sector’s hot streak is unprecedented.
“We are now on an eight-year or nine-year bull run with industrial. It’s unlike anything I’ve ever seen,” Wolff said. “Generally, you see a fall-off and change in the market for 12 to 18 months every five to seven years. I have to think the industrial market will level off eventually. When that happens? I don’t know.”
West agreed that the future looks bright for net lease. He said that real estate in general has performed well even during the pandemic. West said that even the hospitality sector is performing better today.
“If the economy is strong and headed in the right direction, that is good news for real estate,” West said. “Real estate houses the economy. There is always a need for real estate. We are bullish on the future when it comes to real estate. Things are trending in a positive direction.”